U of I professors offer alternative for university retirement plan

Saturday

May 19, 2012 at 12:01 AMMay 19, 2012 at 7:02 PM

SPRINGFIELD -- Gov. Pat Quinn’s proposal to restructure state pensions has gotten a lot of attention since he introduced it in April, but it’s not the only plan on the table. Two University of Illinois professors have suggested an approach they believe would save the state half the money it contributes to the State Universities Retirement System for current employees.

CHRIS WETTERICH

SPRINGFIELD -- Gov. Pat Quinn’s proposal to restructure state pensions has gotten a lot of attention since he introduced it in April, but it’s not the only plan on the table. Two University of Illinois professors have suggested an approach they believe would save the state half the money it contributes to the State Universities Retirement System for current employees.

Jeffrey Brown, a U of I finance professor and director of the Center for Business and Public Policy, wrote a plan along with Robert Rich, director of the Institute of Government and Public Affairs, that would create a hybrid 401(k)-style, defined-contribution system combined with a defined-benefit plan.

Brown estimates their plan would cut in half what the state spends each year on SURS’ “normal cost” — the amount the state spends to cover accrued benefits for active employees. That amount was $463 million in fiscal 2011, according to the Commission on Government Forecasting and Accountability.

No one has projected what the long-term savings could be.

Quinn estimated his plan would save the state at least $65 billion over all five state-funded systems. Regardless, no plan can eliminate the $85 billion in debt the state already owes the systems; proposals can only reduce the cost of future benefits.

6.5-10% interest

The professors’ plan makes three major changes for tier 1 SURS employees, those hired before Jan. 1, 2011. Currently, employees who are in a defined-benefit plan (they have the option today to choose either a defined-benefit and a defined-contribution plan), have two ways to calculate their retirement:

--The traditional way is that a SURS employee receives 2.2 percent of final average salary for each year of service in the system. Members can retire at age 60 with eight years of service or age 62 with five years of service. The final average salary is the average of their salary during the four years in which their salary was the highest.

The math is relatively simple. If a SURS employee retires at age 62 with 30 years of service and a final average salary of $100,000, his or her pension will start at $66,000 a year.

--But two-thirds of SURS members retire using a calculation called the “money purpose option,” It results in a higher pension than the traditional formula and is available to members who entered the system before July 1, 2005.

This complex formula factors in the amount of money a SURS participant has contributed, the amount of money the state is supposed to have contributed, the member’s age at retirement and the “effective rate of interest” — a rate the systems assume such contributions are earning, as set by the state comptroller. The SURS board formrely set the rate.

It is that interest rate that Brown set his sights on in order to reduce the pension costs of tier 1 employees. Since 1973, SURS or the comptroller has assumed interest rates between 6.5 percent and 10 percent, amounts Brown believes are “a huge and hidden taxpayer subsidy to pensioners.”

“They take your contributions, they act as if the state has actually matched the contributions and then they gross it up and credit it with an annual rate of return,” Brown said. “I don’t know about you, but to get what essentially is a risk-free return of 8 or 10 percent is way above any appropriate risk-adjusted measure that anybody else can get in the marketplace.”

No legal challenge

Brown’s proposal does not touch the 3 percent compounded annual interest retirees receive or raise the retirement age, as would Quinn’s proposal. Brown said those would be the first two things he would do if he thought either would be constitutional.

That puts him at odds with Quinn and Senate President John Cullerton, D-Chicago. Both believe the courts will allow the state to offer employees a choice between Quinn’s plan or keeping current benefits, but without counting pay raises toward pensions or receiving a health-care subsidy upon retirement.

“Why would they bother to go through all this and include something in the plan that is almost sure to be struck down by the courts?” Brown asked.

Since the effective rate of interest is already tinkered with every year, tying it to a 10-year U.S. Treasury bond rate or some other external financial index would be constitutional, Brown said.

“…[G]oing forward, it would make that money-purchase option become increasingly relevant over time,” Brown said. “People would just be back on the basic formula.”

The Teachers Retirement System, the state’s largest pension system, has far fewer members opting for its money-purchase option.

TRS’s money-purchase option “usually benefits members with exceptionally long careers or long periods of inactive status,” according to the TRS member guide.

At the end of fiscal 2011, TRS had nearly 91,000 members receiving pensions. The benefits of only about 11,000 were being calculated under the money-purchase option, according to TRS spokesman Dave Urbanek.

Shared sacrifice

The second and third major changes for SURS tier 1 employees, under the Brown/Rich plan, involve who pays for the pensions. The proposal calls for partially redistributing the state’s funding burden to employees and the universities themselves.

-- Universities and colleges would take on part of the employer share, with the percentage of payroll they contribute rising by a percentage point each year until the targeted rate is reached.

“The ability of colleges and universities to undertake this burden is contingent upon the state committing to maintaining at least the current level of state appropriations,” Rich and Brown wrote.

All of the burden should not be shifted to the universities, they wrote, and the state should continue contributing 6.2 percent of university and college payrolls into SURS.

“This is the amount the state would be required under federal law to pay in FICA taxes to support Social Security had the state not opted out of that system,” they wrote.

--The contribution by SURS members would increase gradually from the current 8 percent of pay to 11 percent of pay.

“In the spirit of shared sacrifice and shared responsibility, SURS participants should be asked to pay more,” Brown and Rich wrote.

The plan’s other major element would create a dual 401(k)-style defined-contribution plan that, in concert with a reduced defined-benefit plan, would make SURS participants more financially secure and save the state money.

Tier 2 employees

The reduced benefits provided to tier 2 employees — those hired after Jan. 1, 2011 — have prompted many new university and college employees to opt for an already-existing defined-contribution plan within SURS, Brown and Rich wrote. Under the educators’ plan, tier 2 employees could not retire with full benefits until age 67, would receive lower cost-of-living increases during retirement, wouldn’t have those increases compounded, and would have a cap on the amount of pensionable salary.

SURS employees do not receive Social Security, so those who opt for the defined-contribution plan instead of tier 2 benefits would have virtually no safety net in a complete economic collapse.

“Few pension experts would recommend a 100 percent DC retirement system for employees who do not participate in the U.S. Social Security System,” Brown and Rich wrote.

Their proposal calls for a dual system where employees receive a defined-benefit pension through the following formula:

--They would receive 1.5 percent of their final average salary for each year of service instead of 2.2 percent.

--Savings from the lower multiplier would be shifted to a defined-contribution plan in which each employee would automatically be enrolled.

--A small contribution would be automatically made, along with a 50 percent match of each percent a SURS member contributes, up to 4 percent.

“The hybrid system would increase overall participant confidence that the system will be funded,” Brown and Rich wrote. “While members of the General Assembly can choose to underfund defined benefit plans … no third-party defined contribution vendor will accept IOUs in lieu of real retirement plan contributions.”

Few employees would automatically be enrolled in the hybrid system. Tier 1 and 2 employees could voluntarily join the new plan.

Live option?

Unions and lawmakers involved in the ongoing pension talks did not return calls attempting to gauge whether Brown and Rich’s pension ideas are in the mix of ideas under consideration.

Brown, who served as a senior economist in the White House Council of Economic Advisers from 2001 to 2002, said state lawmakers are aware of their idea, but he has only heard secondhand information about whether they’re interested in incorporating it.

“I keep being told the idea of a hybrid is a live option,” Brown said. “I think everybody who has a role to play in this has read it and been briefed on it by someone. … I think the idea has clearly entered into the debate. There’s no evidence from any of the legislative proposals being put forward that we’ve actually had an impact.”

The lack of a defined-contribution element to Gov. Pat Quinn’s plan makes it a “missed opportunity,” he said.

“We’re dealing with more than one problem here. One is we’ve got the unfunded liability. Two is we’ve got to reduce costs and redistribute the costs. Third, the tier 2 system that’s in place … is really putting us at a competitive disadvantage because of the way they’ve structured it,” Brown said.

The two professors’ approach is a way “to save the state a heck of a lot of money but also allows universities to compete for the talent that we’re trying to compete for,” he said. “That issue seems to be completely ignored in the governor’s proposal.”

Chris Wetterich can be reached at (217) 788-1523.

How the professors’ plan could save the state money:

--The state’s normal cost for State University Retirement System pensions is roughly 13 percent of payroll. In fiscal 2011, the state paid $463 million.

--Shifting part of the normal cost to employees and universities and colleges through increased contributions would knock off at least 5 percentage points.